Economic activities are not always consistent in all years. There are times when economic activities are increasing gradually while in other times, they decrease below the normal level. The changes in economic activities happen over a long period, and involve four phases; expansion, recession, contraction, and recovery. Business cycles are unpredictable, thus they may affect people negatively or positively. They result in either inflation or unemployment. The business cycle is left to run by itself, but in many economies, the government intervenes to correct the misfortunes. This study will focus on why the governments intervene in the business cycle despite their incompetency in correcting the economic activities.
Why the Governments Intervene in Business Cycle
The government will always intervene whenever the economy seems to be fluctuating. Before WWI, most of the world economies allowed markets to run independently. However, as the war progressed, the governments began to take large control of their economies. Each economy established price control and limited production. This resulted in inflation when prices between countries became dissimilar. The government can influence output by decreasing tax rates and increasing its spending, thus, stimulating output by increasing aggregate supply (Knoop, T. A. 2010, 90). High government spending has been responsible for economic deficits.
When an economy is in recession, social problems, such as crime, suicides, and mental health, are liable to increase. The government may intervene by offering free counseling services in public healthcare and public awareness forums. During recessions, the private sector stops spending on investment, resulting in decreased economic growth. A prolonged period of stagnation in the economy causes unemployment and political instability in the country. The government will intervene in such situations to create equality. The government reacts through borrowing from the private sector to invest in sectors that would increase employment opportunities.
To decrease the chance for an economic boom, the government can employ fiscal policy to minimize the phenomenon. Fiscal policy involves the government’s attempt to adjust its expenditure levels and tax revenues to check on the country’s economy. Fiscal policy is derived from Keynesian theory, which indicates that the government is capable of increasing the macroeconomic productivity of a country through regulating tax rates and public expenses. For instance, the US government created a fiscal cliff, which led to an increase in tax rates and a decrease in spending in military and domestic programs (Calmes J. 2012). Some analysts claimed that the reduction was too much and sudden while others argued that it was manageable.
Government intervention usually aims at striking for equity, as well as social efficiency. The Depression that occurred in the 1930s created a harsh contraction in the American economy. The real GDP (Gross Domestic Product) decreased for a period of four years before it settled for recovery. The government reacted by creating a monetary contraction, which involved decreasing the money supply for a period of four years. The government’s step shrank the money supply, causing delicate economic fears. The creation of a new Social Security tax in the 1930s led to increased compensation costs.
Private sectors may decide to increase prices of basic goods in times of recession, making consumers avoid certain goods. The government may opt to intervene by offering subsidies on basic goods to enable consumers to afford those goods. Regulatory bodies can be established to monitor activities that go against the interests of the public. In addition to this, laws can be drafted to manage monopolies and oligopolies, for the benefit of consumers. The government may choose to take goods directly to the consumers to minimize costs. The government can also implement bank regulations to safeguard its citizens from exploitation through high-interest rates.
The government can intervene with the market to decrease the market failure. Goods, such as education and health are utilized by the public, and their providers may not be economically profitable to private investors. Universal education that the government offers ensures that every child will be educated to a certain level. Since the discovery of oil in Saudi Arabia in the 1930s, the country has experienced a shortage of skilled labor force. This is because the private sector has invested a little in education. The government has taken steps in establishing more schools, In addition to encouraging women to gain skills in education and modern technology. The government has also offered subsidies in institutions that offer higher education skills to increase the number of skilled workers. The Saudi’s development plans of the 1970s focused on infrastructure. When the government exhausted spending on infrastructure, it turned to education and social services.
Governments are not proficient in correcting economic fluctuation, but their contribution should not be overlooked. The government can intervene to change income distribution or to correct a market failure. By investing in education, every citizen has a chance to benefit from education and improve his/her welfare. Business cycles are unpredictable, thus, any attempt by the government to influence the market may not succeed in the long term. Occasionally, the government utilizes fiscal policy or monetary policy to overturn the market situation. Governments should leave the business cycle to sort itself out to enhance efficiency in the market.
Calmes J. 2012, Demystifying the Fiscal Impasse That Is Vexing Washington. The New York Times, November 15, 2012. Available from http://www.nytimes.com/2012/11/16/us/politics/the-fiscal-cliff-explained.html?pagewanted=all&_r=0 [Accessed 31 March 2014]
Knoop, T. A 2010, Recessions and depressions: understanding business cycles. Santa Barbara, Calif, Praeger